Making crypto a more sustainable investment

The pop­u­lar­i­ty of ESG invest­ments has rock­et­ed in recent years, while cryp­tocur­ren­cies are com­ing to be viewed as a hedge against infla­tion in this era of ultra-low inter­est rates. The ques­tion for investors is: can the two ever be com­pat­i­ble? 

Cryp­to fever is start­ing to infect wealth man­age­ment, as some pri­vate bank­ing insti­tu­tions have respond­ed to demand from their clients. In March, Mor­gan Stan­ley became the first big US bank to offer its wealth man­age­ment clients access to bit­coin funds. JPMor­gan Chase fol­lowed suit in August, even though its chair­man and CEO, Jamie Dimon, admit­ted that he con­sid­ered bit­coin to be “worth­less”. 

The argu­ment that cryp­to, unlike a phys­i­cal asset such as gold, has no intrin­sic val­ue is just one of the rea­sons why most oth­er play­ers in the sec­tor have steered clear of the asset class so far. 

If cryp­to is ever to be added to ESG port­fo­lios, it will be sub­ject to much scruti­ny, par­tic­u­lar­ly regard­ing the envi­ron­men­tal ele­ment. It has been well report­ed that bit­coin min­ing – the com­pu­ta­tion­al process of pro­duc­ing new coins – con­sumed more elec­tric­i­ty last year than the whole of Argenti­na did. 

The boom­ing pop­u­lar­i­ty of bit­coin min­ing in Kaza­khstan, for instance, has led to ener­gy short­ages in recent weeks. These have been caused by a ban on the activ­i­ty in neigh­bour­ing Chi­na, which prompt­ed min­ers there to move their oper­a­tions across the bor­der.

On the flip side, there are min­ers who active­ly off­set their green­house gas emis­sions. Some are explor­ing the pos­si­bil­i­ty of using renew­able resources, while oth­ers are focus­ing on clean ener­gy goals. One such project is blockchain com­pa­ny Efforce, led by Apple co-founder Steve Woz­ni­ak. Hold­ers of its cryp­tocur­ren­cy token, WOZX, are enti­tled to a share of prof­its from ener­gy-effi­cien­cy projects. 

Eco­log­i­cal con­cerns about cryp­to are not shared by the social­ly con­scious investors who’ve spo­ken to Daniel Wolfe. He’s the co-founder of Simoleon Long-Term Val­ue, a fund with a min­i­mum invest­ment lev­el of $100,000 (£75,000) that specif­i­cal­ly pro­vides expo­sure to cryp­tocur­ren­cies and blockchain-relat­ed assets.

“The need to increase the use of green ener­gy sources is crit­i­cal, regard­less of the amount of elec­tric­i­ty being con­sumed, but we shouldn’t con­flate issues con­cern­ing min­ing with cryp­tocur­ren­cies in gen­er­al,” Wolfe stress­es. “When peo­ple talk about cryp­tocur­ren­cies and sus­tain­abil­i­ty, they’re usu­al­ly refer­ring to bit­coin. Its proof-of-work con­sen­sus mech­a­nism, which is used to val­i­date trans­ac­tions, does require large amounts of com­put­ing pow­er.”

Can crypto go green?

But some cryp­to assets are start­ing to rely instead on what’s known as a proof-of-stake mod­el, he adds. This is a less ener­gy-inten­sive process that’s also faster and cheap­er. Ethereum plans to switch to proof of stake in 2022, for instance, although no date has yet been set for bit­coin. 

In effect, min­ers are com­pet­ing to pro­duce coins under the proof-of-work sys­tem. Under proof of stake, min­ers must pledge coins in order to take part. As a result, there are few­er par­tic­i­pants.

“There’s a clear move­ment: devel­op­ers of new cryp­to projects are becom­ing con­scious of their envi­ron­men­tal impact, so they’re shift­ing from proof of work to proof of stake,” notes Philip Rad­ford, direc­tor at Saf­fery Champ­ness Reg­is­tered Fidu­cia­ries. “While the answer isn’t just to use renew­able ener­gy to pow­er their net­works, this is cer­tain­ly a good start­ing point.”

Beyond the envi­ron­men­tal con­cerns, there are oth­er ESG issues that wealth man­agers and their clients will need to con­sid­er when approach­ing cryp­to invest­ment oppor­tu­ni­ties.

Jere­my Cheah, asso­ciate pro­fes­sor of decen­tralised finance at Not­ting­ham Trent Uni­ver­si­ty, points to the mat­ter of gov­er­nance. Cryp­tocur­ren­cies have no CEO or board, but their cre­ators have been known to pub­lish white papers set­ting out a dig­i­tal token’s real-world use, there­by help­ing poten­tial investors to gauge how sus­tain­able it might be. Nonethe­less, the gen­er­al lack of account­abil­i­ty means that the sec­tor remains shroud­ed in mys­tery. 

“Investors should not feel restrict­ed – there is huge upside for ESG and cryp­tocur­ren­cies,” says Cheah, but he adds: “The ques­tion is whether they under­stand all the risks or not.”

Other ESG considerations

Anoth­er ESG weak­ness of cryp­to con­cerns the sector’s diver­si­ty – or lack there­of. For instance, a report pub­lished in 2019 by cam­paign group Diver­si­ty in Blockchain crit­i­cised a dearth of female and eth­nic minor­i­ty rep­re­sen­ta­tion in the cryp­tocur­ren­cy sec­tor, par­tic­u­lar­ly at lead­er­ship lev­el. 

Appro­pri­ate reg­u­la­tion could ensure bet­ter gov­er­nance stan­dards and make this indus­try more diverse and inclu­sive. In the­o­ry, it could also help to make cryp­to mar­kets less volatile. For instance, the price of bit­coin plum­met­ed by 20% after the emer­gence of Covid’s omi­cron vari­ant was first report­ed. 

Mit­i­gat­ing such risks, along with reduc­ing the ener­gy con­sump­tion of the min­ing process, should strength­en the appeal of cryp­to as a long-term invest­ment oppor­tu­ni­ty, accord­ing to Cheah. More­over, if the asso­ci­at­ed trans­ac­tion fees, which are received by min­ers, can be low­ered, this will incen­tivise investors to buy sus­tain­able cryp­tocur­ren­cies.

He adds that, while cryp­to clear­ly has its down­side risks, not all ESG projects will pro­vide good returns in the short to medi­um term. Invest­ments in cryp­to and ESG are there­fore com­pat­i­ble in the sense that both have the poten­tial to deliv­er gains over the longer term.

Rad­ford stress­es that blockchain is still “a young tech­nol­o­gy. It will evolve and take a few more years to mature, but cryp­tocur­ren­cies will inch clos­er to being envi­ron­men­tal­ly friend­ly.” 

The num­ber of use cas­es for blockchain-based sus­tain­abil­i­ty, such as using dig­i­tal assets to raise ESG finance or trad­ing car­bon cred­its on dig­i­tal mar­kets, will only grow. This should encour­age more investors and wealth man­agers to con­sid­er expos­ing their ESG port­fo­lios to cryp­tocur­ren­cies. 

Wolfe says that his advice for investors who have been “con­vinced about the trans­for­ma­tive nature of blockchain and cryp­to assets” would be: “Don’t let cur­rent eco­log­i­cal con­cerns hin­der your invest­ments.”